Stocks closed out their best week since November 2020, as buy-the-dip investors sprang into action after the market started the week from an oversold position. This week’s big move came even after the Federal Reserve raised its benchmark rate for the first time since 2018, as the Fed move was widely expected, which helped embolden bullish sentiment. Investors also weighed a denial that China is considering support for Russia and mixed signals from peace talks between Russia and Ukraine. Technology shares led stock gains after investors endured a $3.5 trillion triple witching event and a rebalancing of benchmark indexes including the S&P 500, a combination that tends to spark strong single-day volumes. For the week, the Dow Jones index jumped 5.5%, the S&P 500 spiked 6.1% and the Nasdaq Composite surged a stunning 8.2%
The Federal Reserve kicked off its tightening cycle with an expected quarter-point hike and the stock and bond markets had different reactions. The FOMC hiked rates by a quarter point.
That was expected, but the summary of economic projections took what many saw as a hawkish tilt, with the median forecast for rates to end 2022 at 1.9%, up from 0.9% in December, and the majority of Fed officials looking for seven hikes this year. Officials see rates at 2.8% at the end of 2023, up from 1.6% at the previous Fed meeting.
Threading the needle: Stocks sold off right after the release of the statement and dot plot, with the S&P 500 (SPY) dipping into negative territory. But they quickly resumed rally mode as Fed Chairman Jay Powell spoke, seemingly taking heart at him downplaying the possibility of recession.
“Asset markets treated the FOMC statement and projections as unambiguously hawkish on release but reacted more positively as the press conference progressed,” Standard Chartered strategist Steve Englander wrote. “Powell’s mention that the balance-sheet drawdown may be worth an extra hike and a comment on the easing of goods price inflation (however small) may have calmed market fears a bit.”
“We think the Fed is probably pleased with this reaction,” he said. “Equity markets closed higher, suggesting that investors saw the Fed stance as threading the needle between tolerating inflation and threatening a major downturn.
Notably, stocks are coming off a correction in the broader market and a bear market among growth names. But this looks like a vote of confidence from the equity market that, after admitting it is behind the curve, the Fed won’t overreact and slam the brakes too hard.
While Powell definitely came out with a hawkish message, the U.S. economy looks less vulnerable to shocks and a possible recession than other global economies, Goldman Sachs economist Steffan Ball said on Bloomberg.
Trouble with the curve: The Treasury market doesn’t look too convinced that a soft landing is on the cards.
Bonds followed a similar path as stocks yesterday afternoon, with prices plunging and yields spiking on the release of the statement, especially on the short end, then changing direction as Powell spoke. There was further flattening of the Treasury yield curve and an inverted 2s-10s curve is generally considered a warning of an impending recession.
There is “a remarkably flat curve for the very beginning of the rate hiking cycle,” ING economists said. “The 2yr went into the meeting at quite an aggressive discount versus the funds rate anyway, one reminiscent of rate hike cycles that were typical before the great financial crisis, when 50bp hikes were not unusual,” ING added.
The 5s-10s curve inverted for the first time since March 2020.
On average, “it takes around three years from the first Fed hike to recession,” Deutsche Bank’s Jim Reid said. “However the bad news is that all but one of the recessions inside 37 months (essentially three years) occurred when the 2s10s curve inverted before the hiking cycle ended.”
“With all the recessions that started later than that, none of them had an inverted curve when the hiking cycle ended,” he added. “In fact, hiking cycles that ended with the curve still in positive territory saw the next recession hit 53 months on average after the first rate hike, whereas the next recession for hiking cycles that ended with an inverted curve started on average in 23 months, so just under two years.”
“As a reminder, none of the US recessions in the last 70 years have occurred until the 2s10s has inverted. On average it takes 12-18 months from inversion to recession. The problem is that all but one of the hiking cycles in the last 70 years have seen a flatter 2s10s curve in the first year of hikes. The exception saw a very small steepening. So these are the risks.” (43 comments)
COVID restrictions have come to an end in many parts of the world as governments establish “live with the virus” policies, but one nation stands out in this regard: China. The country has continued to pursue a “zero-COVID” strategy, imposing strict lockdowns and containment measures to prevent viral transmission among its population. However, a growing wave of local cases is seeing authorities double down on the policy and that’s getting investors nervous about the economy:
What happened? China just placed the 17.5M residents of Shenzhen into lockdown for at least a week, which will be accompanied by three rounds of city-wide testing. All bus and subway systems were closed, while businesses, barring those that provide essential services, have been shuttered. The decision resulted in Foxconn (FXCOF), a key Apple (AAPL) supplier, to halt production as the virus spreads across the technology hub. Shenzhen also features the headquarters of tech giants Huawei, BYD (BYDDY) and Tencent (TCEHY).
Similar measures are impacting Hong Kong, Shanghai and other regions as a spike in coronavirus infections leads to a worsening outbreak. The Hang Seng Index (HSI) plunged 5% on Monday, shares in Shanghai dropped more than 2%, while the bad news keeps piling up as U.S. officials said Russia asked China for military assistance for its war in Ukraine. The developments could also compound supply chain disruptions that have contributed to a rise in global inflation.
Analyst commentary: “The COVID situation in China has deteriorated at an alarming pace over the past week, but abandoning zero-COVID now could be perceived as conceding that the strategy did not work in the first place,” said Ting Lu, chief China economist at Nomura. “With the much worsening pandemic and Beijing’s resolution in maintaining its [zero-COVID strategy], we believe China’s ‘around 5.5%’ GDP growth target this year is becoming increasingly unrealistic.” China sets 2022 GDP growth at 5.5%, lowest since 1991. (136 comments)
‘Economically assured destruction’
China may be reluctant to court an economic battle with the West given problems it’s facing domestically that have forced the government to reassure risk markets, not to mention its continued battle to contain COVID.
Widely followed J.P. Morgan strategist Marko Kolanovic wrote in a note yesterday that economic tail risks from China likely won’t materialize.
“During the Cold War, peace was preserved by the virtue of ‘mutually assured destruction’; for the time being, the current relationship with China may be preserved by the equivalent of economically assured destruction,” he said.
Rally mode: This week, China saw the biggest two-day rally in 1998. BTIG said China stocks saw the volume and velocity of a “washout,” but warned that 9% gains weren’t usually indicative of a low. The buying of the beaten-down shares was spurred by a government pledge for stock-friendly policies that would stabilize markets, stimulate the economy and not expand a trial of property tax reform.
“This ‘equity put’ saw Vice premier Liu’s all-in attempt to try to clear up all investor concerns in one go, from ‘as soon as possible’ end to tech sector crackdown, to a commitment to resolving property developer risks,” eToro strategist Ben Laidler said.
“We see little appetite from the authorities to provoke more trade disruption,” he added. “As the world’s largest manufacturer and exporter they have the most to lose.”
“The market is one of the world’s cheapest, with a P/E ratio of 9x.”
Kolanovic said he is still bullish on Chinese equities “as the fiscal carry-over for 2021 allows for the front-loading of stimulus in 2022.” (34 comments)
Inflationary pressures are hitting everywhere, from the production line to consumers’ pockets. For the second time in less than a week, Tesla (TSLA) is raising prices in the U.S. and China to cope with the costs of raw materials. Prices have surged in recent month, from aluminum and palladium used in bodywork and catalytic converters to nickel and lithium that power EV batteries.
Quote: “Tesla & SpaceX are seeing significant recent inflation pressure in raw materials & logistics. And we are not alone,” Elon Musk tweeted earlier this week, before challenging Vladimir Putin to a duel over Ukraine.
The latest increases saw Tesla raise prices for all its American (and Chinese) models by 5%-10%. Its cheapest vehicle, the Model 3 Rear-Wheel-Drive, even went up $2,000 to $46,990. Last week, the company raised prices of its U.S. Model Y SUVs and Model 3 Long Range sedans and some China-made Model 3 and Model Y vehicles.
Supply chain complications: CNBC reported on Monday that Tesla bought “millions of euros worth of aluminum” from Rusal, the Russian metals giant founded by sanctioned oligarch Oleg Deripask. The transactions go back to 2020, though there’s no indication that Rusal aluminum has been used in U.S. production. Its willingness to work with Russian suppliers is also not unusual. Almost all of the world’s biggest automakers buy from at least one tier-1 supplier in Russia, according to global supply chain research firm Interos. (107 comments)
Ahead of its annual shareholder meeting today, Starbucks (SBUX) laid out some steps it could take on the sustainability front. One of those included plans to establish an electric-vehicle charging network with partner Volvo at Starbucks (SBUX) stores nationwide. The other centered around reducing its disposable cup use, which is not only a crucial utensil for coffee giant, but features its iconic green-and-white colors.
Wait, what? Starbucks is embarking on 20 different types of tests – across eight markets – to figure out the best way to ditch the single-use cup. One will test financial incentives for reusable mugs or deterrents for disposables, while another will explore washing stations, where customers will be able to have their personal cups cleaned before ordering a beverage. A borrow-a-cup program is also in the works, where a deposit is paid for a reusable cup until they are returned to stores (plastic straws will additionally be replaced with compostable options).
Starbucks’ environmental commitments have made the stock popular among ESG investors, but shares have slipped 35% from highs notched in July as the company battles costs and economic uncertainty. That even prompted the company last month to cut its earnings outlook for fiscal 2022. “Although demand was strong, this pandemic has not been linear and the macro environment remains dynamic as we experienced higher-than-expected inflationary pressures, increased costs due to Omicron and a tight labor market,” CEO Kevin Johnson said at the time.
It won’t be easy: Back in 2008, Starbucks (SBUX) set a goal to have a quarter of consumers use reusable cups by 2015, but it fell seriously short of the target. The company has also offered a $0.10 discount on every order for a personal cup or mug since the 1980s, but few customers have taken up the offer (or even know about it). “Disposable cups and lids make up 40% of Starbucks’ packaging waste,” according to its Chief Sustainability Officer Michael Kobori. (20 comments)
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